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Court Rejects Bank of America–Merrill Settlement, Changes Securities Landscape

By Jeffrey B. Tracy, Litigation News Associate Editor – January 5, 2010

The United States District Court for the Southern District of New York rejected an SEC proposed $33 million securities fraud settlement, changing the landscape of the court’s review of executive pay and business judgment.

The SEC filed a complaint alleging that Bank of America (BOA) lied to its shareholders regarding bonuses given to executives of Merrill Lynch just prior to the merger of the two companies and at the height of the financial crisis. The complaint alleged that prior to a shareholder vote to approve the merger, BOA executives represented that Merrill had agreed not to pay any bonuses until after the merger. Evidence uncovered later, however, allegedly showed that Merrill had already paid out $5.8 billion in bonuses prior to the vote.

The parties reached an agreement and presented a proposed consent judgment to the court for approval. Instead of granting approval, the court ordered the SEC to provide an explanation as to why it agreed to a settlement without challenging BOA executives’ contention that their attorneys had advised them not to disclose the payment of the bonuses to shareholders. The court required a further explanation as to who should be accountable for the bonus disclosures decision.

Proposed Consent Judgment
After the follow-up hearing this fall, the court denied the parties’ proposed consent judgment and issued an order [PDF] calling the parties’ arguments “absurd” and “hollow.” The court found the proposed judgment to be unfair, unreasonable, and inadequate.

The proposal failed to “comport with the most elementary notions of justice and morality, in that it proposes that the shareholders who were the victims of the Bank’s alleged misconduct now pay the penalty for that misconduct,” the court order says.

It “suggests a rather cynical relationship between the parties: the SEC gets to claim that it is exposing wrongdoing on the part of the Bank of America in a high-profile merger; the Bank’s management gets to claim that they have been coerced into an onerous settlement by overzealous regulators,” the opinion states.

The parties’ submissions left “the distinct impression that the proposed Consent Judgment was a contrivance designed to provide the SEC with the façade of enforcement and the management of the Bank with a quick resolution of an embarrassing inquiry—all at the expense of the sole alleged victims, the shareholders,” the opinion says.

Questioning why the SEC did not further investigate the BOA attorneys, the court opinion notes the “SEC states, as noted, that culpable intent was nonetheless lacking [as to BOA executives] because the lawyers made all the relevant decisions. But, if so, then how can the lawyers be said to lack intent?” Further, the executives’ testimony that the lawyers made the decisions “would seem to invite investigating the lawyers.”

Fallout from the Decision
“There is no immediate reason to believe that the decision has broader implications for more heightened scrutiny of securities class action settlements generally,” says Barrie Brejcha, cochair of the ABA Section of Litigation’s Securities Litigation Committee.

The court’s decision was the product of a “perfect storm,” Brejcha opines. “The SEC’s Division of Enforcement has been the subject of harsh criticism from the media, congress, and its own inspector general in the wake of the subprime credit market crisis and the unprecedented Madoff scandal,” she says.

“At the same time, the Obama Administration has called for increased financial reform and greater regulation of financial institutions. And the New York attorney general is reportedly investigating the circumstances surrounding the acquisition of Merrill Lynch,” she says.

“Given this environment and the parties involved, Judge Rakoff likely felt empowered—if not obligated—to scrutinize the settlement proposal even more closely to ascertain whether it was ‘fair, reasonable, and adequate’ and served the public interest,” says Brejcha.

Some judges, however, armed with Judge Rakoff’s order and a plethora of public support might very well continue to scrutinize securities settlements, demanding more from the SEC in holding corporate defendants accountable, some litigators speculate.

Lynda Grant, New York, cochair of the Section’s Class Actions & Derivative Suits Committee, has always found judges to be extremely engaged in the settlement approval process. “Judge Rakoff’s order, however, is unusual in that it brings to light an issue that the Obama administration has brought to the forefront—executive pay,” says Grant.

“Judge Rakoff’s order seems to indicate that courts will no longer completely defer to a board’s business judgment in determining the issue of executive pay. No doubt this has arisen out of the public backlash against executives stemming from the financial crisis,” she says.

On a practical level, Grant believes that “this could be a signal that we could see a rise in derivative claims by shareholders for waste in relation to salaries, bonuses, and other benefits paid out to executives.”

Trial in the case is currently set for February 2010.

Keywords: Litigation, securities, SEC, executive pay, consent judgment


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